Frankfurt The European Central Bank (ECB) sees further vulnerabilities in the financial system due to the pandemic. “The risk of high corporate loan defaults and losses for banks is now significantly lower than it was six months ago. But the risks of the pandemic have not completely disappeared, ”said Vice President Luis de Guindos at the presentation of the central bank’s semi-annual financial stability report on Wednesday.
In it the ECB warns of price corrections on the financial markets. The central bank sees vulnerabilities above all in the real estate markets in countries where there were already high valuations before the pandemic.
In her report she identified the four biggest risks for the financial system.
The ECB is particularly concerned about developments in the real estate market. Prices there rose faster in the second quarter of 2021 than since 2005. The prices for residential real estate recently rose by around seven percent. The increase was broader, affecting both urban and non-urban areas.
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In some countries such as Luxembourg, Slovakia, Lithuania, but also in Germany and Austria, the demand for real estate loans has also increased significantly. At the same time, the ECB is recognizing “signs of easing standards for mortgage lending”.
In view of the development, the ECB sees stronger arguments for the use of macroprudential regulation. For example, there are regulations to make it more difficult for banks to grant loans.
According to the central bank, there is also a risk of price correctors for commercial real estate, even if the prospects there have recently improved thanks to the economic recovery.
She considers the perspectives for objects of low quality to be particularly poor. As a result of trends such as teleworking, distance rules and higher environmental requirements, demand is tending to shift even more to the top segment. Segments affected by the pandemic, such as retail and office real estate, are also particularly susceptible to corrections.
Investors are also taking higher risks in other market segments outside of the real estate industry. Last year, inflation-adjusted real returns were at an all-time low. At the same time, the ratings are comparatively high. According to the ECB, this combination harbors the risk that certain bonds with a poorer rating and the equity markets will react very sensitively to interest rate hikes or lower growth prospects.
She cites a weaker economic recovery, crises in emerging countries, problems outside the banking sector and abrupt changes in market expectations about monetary policy as possible triggers for a correction in the markets.
2. Banks weaknesses
The structural problems faced by the banks are another worrying factor. Overall, the financial institutions in the euro area have recently benefited from a better environment. The bottom line was that they achieved better results than expected in the first half of the year. The further profit prospects depend heavily on the economic recovery after the pandemic.
The ECB sees banks’ non-performing loans as an important weak point. In their view, there is a risk that the problems could worsen if the state support measures gradually expire.
From their point of view, another problem is the banks’ still low profitability, which is lagging behind their competitors from other countries. The causes are low cost efficiency, overcapacities and low margins due to the low interest rate environment. According to the ECB, one solution would be mergers and acquisitions. These could be “a possible way for the sector to return to a more sustainable level of profitability”.
3. Problems outside the banking sector
The ECB not only sees specific problems in the banking sector. Other financial players such as investment funds, insurers and pension funds could also face difficulties. In their search for returns, they have increasingly invested in riskier forms of investment.
Mutual funds, for example, would invest more in high-yield bonds. Insurers and pension funds also invested more heavily in debt securities from companies with poor ratings. “While reduced corporate sector vulnerabilities reduce related credit risks in the short term, non-banks remain exposed to the risk of significant credit losses should corporate sector conditions deteriorate,” it said.
4. Increasing bankruptcies
Contrary to what was initially feared, there has not yet been a major wave of bankruptcies despite the pandemic. The bankruptcy rate has been below the most optimistic expectations.
Nevertheless, the “bankruptcies in the sectors most affected by the pandemic have risen sharply,” says the report. This segment is still very fragile, warns the central bank. She fears that once the support measures expire, the number of bankruptcies could increase even more.
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